Transcript for John Mauldin: It’s Time to Make the Hard Decisions

Below is the transcript for the podcast with John Mauldin:  It’s Time to Make the Hard Decisions

Chris Martenson:  Welcome to another podcast. I am your host, of course, Chris Martenson. And today we are speaking with John Mauldin, author of the widely read investment newsletter, Thoughts from the Frontline, and bestselling author – his most recent book, Endgame: The End of the Debt Supercycle and How It Changes Everything It came out last year at a high praise and could hardly be more relevant to the moment in history in which we currently find ourselves.

Today, he and I will explore the most probable outcomes of the global economy, and we’re going to be looking at how and what might happen when we’re finally forced to deal with its fundamental Achilles heel, which can be perfectly summarized in three short words: too much debt.

John, welcome. It is a real pleasure to have you as a guest today.

John Mauldin:  It is always a pleasure to be with you, and thanks for the very kind words and introduction.

Chris Martenson:  You’re most welcome. What I’d like to do today is tap your expertise in explaining the difficult in such a way that everybody can understand what the issues really are. There is so much complexity involved in the global economic and financial situations today that it can seem overwhelmingly complex to the average or casual visitor to that rugged landscape. So, if we just back up a bit though, if we widen our view to the macro, I think it’s possible to understand where we are, how we got here, and where we might be headed next. So, before we get into the particulars of Europe or the U.S. or any other region, could we start today with the debt super cycle – what it is and why understanding it can help us figure out where everything might be headed?

John Mauldin:  Well, Irving Fisher, back in the 30s, began to talk about the debt supercycle. Most people that are in investments and economics will remember Irving Fisher for his statement in 1929 that the stocks were at a “permanently high plateau” in October, just before they crashed. That’s what we remember him for.

However, he was probably one of the greatest economic minds of the last century – of any time. He gave us so many equations and so many insights that are fundamental to everything we do today. He was the founder… kind of the groundwork for a lot of people – Keynes, Schumpeter, Kindleberger, Minsky. And, he began to talk about that the problem that they had in the 20s, and went back and he was looking at the 70s – 1870s, 1820s. If there’s a buildup of too much debt… and when you get too much debt, he said, there’s nothing you can do other than just let it rewind.

You can’t take monetary policy, which is to try to stimulate businesses to get more debt because debt is the problem. If you are drunk and you need to cure yourself, another fifth of the whiskey is not the answer. So, when debt becomes a problem, when it gets to be too much, more debt is not the issue. You just simply got to work it off. And, as he pointed out, and other people who – for instance the bank credit analyst named it the debt super cycle. There’s no easy way out of it. And, it takes years to work through it. That’s what McKinsey Institute, when they did their analysis, has recently showed.

And, it’s not every recession. It takes a long time – generally 60 to 70 years, in the U.S. case – for these debt cycles to build up. It’s when you can no longer adequately service your debt and the market loses confidence in your ability to service the debt at a price that they find adequate.

For instance, the United States will never not be able to service its debt. We can print money, so can the UK. They are always going to be able to service their debt. The question becomes, if they have to start monetizing it, what rate of inflation? What is the price that you are going to be paid for? Because you are going to be paid in dollars in the future that you’re lending today. What are the values of those dollars going to be? Bond investors and sovereign debt are unusual breeds in the sense that they don’t want any risk. I’ve got to emphasize that over and over again. They’re not looking to take risk.

When you buy a government bond, you are saying, I want the least amount of risk possible. So, when they start seeing risk, they go, oh, this is not what I signed on for, guys. And, they either start asking for higher interest rates or they retreat from the market altogether. And, typically at some point, they retreat from the market altogether. The only people that will go in are people that are buying distressed debt, which is what we’re finding in Europe now. That’s why Greek rates are something like 90%. Portuguese rates are pushing 18-19% already.

The people that are buying it are people that are buying distressed debt. The people that are selling it are saying I’ll take anything for it, whatever I can get. The people that are buying it, expect a default and so they’re figuring the default into the price they are paying. Well, when that happens, a country can no longer refinance its debt at a rate that they can make the payments. Italy, at a mere 7% interest, their debt is… they have so much debt. It’s pushing, it’s well over 120% of GDP. Well, that means it would take almost 9% of their total country’s output just to pay the interest on the debt. That’s not a working business model.

It’s only 9%, but if you’re paying 9% of your income and you’ve still got to pay for your housing, you still got to pay for your food, you still got to pay for your kid’s education, and you’re paying 9% of everything you make after taxes… I mean, 9% of everything you make before taxes and you still got to pay your taxes. It ends up taking 20% of what’s available before you pay for anything else. That business model doesn’t work on individual levels. The same thing is true on country levels. So, we rock along and rock along. You can borrow more money, you can borrow more money until you can’t. And, there’s no magic number. There’s no, well you’re 80% or at 60% or at 120% or in the case of Japan, 240%. It’s when the market no longer says we think you can pay at a rate that is going to pay us for the risk.

Chris Martenson:  Now, this is an interesting point I’d like to follow because I think there is something new in this cycle – at least new to my observation – which is that the bond market I think was a wonderful, incredible arbiter of prices and enforcement at some point. And, we’ve seen recently – and by recently I mean the last ten years – the emergence of the non-economic players. I’m code speaking about central banks now, which are in my view heavily distorting the bond markets through their actions; quantitative easing, the bond purchases, the balance sheet expansions.

What’s your view of the impact of these non-economic participants in distorting the true yields that we’re seeing in the bond markets today? I mean, if you’re a pension fund you are captive to the idea that you’re going to get zero percent on safe short-term money. That may or may not be a true market reflection of what the interest rate ought to be. I think it’s not. I think it’s way too low, given the risks involved here and the inflation rates that are likely if not probable going forward.

So, what’s your view on the central banks? Are we in a new economic landscape? Can they really hold this together forever by printing? Or, am I missing something here?

John Mauldin:  It all depends on what you mean by central banks holding it together. If you mean can they help us kick the can down the road, yes. But, they can’t provide stability. We just simply have too much debt. There is no amount of central bank printing that can make that smooth. If they were just to provide the money Greece and Portugal is going to need, let alone Ireland, that will create inflation in Europe. Now, maybe 4-5% inflation is your definition of smooth. A lot of bond market investors would go no, we don’t think that’s smooth. And, if they have to try to do something with Italy, forget about it.

The problem is, there’s only really two ways that you can deal with the debt. You can grow your way out of it, which is what you can do in normal business cycles. For most times in most places, we can grow our way out of debt problems, which is what the central bank is coming in and trying to do. The problem is, when you’re at the end of the debt super cycle, when you’re running up against your ability to borrow money, that liquidity no longer works. Now, the US isn’t there yet.

We have an opportunity in this election, 2012 and then in 2013 with the new congress to get our deficits under control. It’s not without paying, which is what I’ve been writing. When you start reducing your leverage, you’re locking in a slower growth economy. We’ve used leverage to help boost our growth. Or, when you take that leverage off, you have that reverse effect.

As Fisher pointed out, the time to solve the debt bubble is before it becomes a bubble. He was wanting,, separation of commercial banks and lending. He wanted a much less fractional reserve-based banking because he wanted the debt to keep from building up past levels that we saw in the 20’s. He saw that as something that was so bad that it created the depression. What we don’t have from Fisher, sadly, is he never wrote the definitive book like Keynes did, like Friedman did, like von Mises did. What we’ve got from Fisher is his writings and especially his letters to Franklin Roosevelt towards the end of Roosevelt’s, in the 30s and the end of his career.

What you get is one of the greatest intellectuals of all time commenting on what happened and what you have to do. One of the things you have to do is just, you have to work that debt off. So you can either repudiate the debt, you can default on it, you can monetize it, you can try to grow your way out of it, but you’re going have to deal with it. And, there’s no easy way when you’re at the end of the debt super cycle, when debt has become too much. Printing money, as Fisher said – in which he advocated early on – but later he said, guys this doesn’t work.

Now, upon reflection and thinking about it, we’ve gone too far. And, this is where they are in Europe. Japan is getting very, very close to that moment. I keep saying, I think Japan is a bug in search of a windshield. I think they’re going to collapse. Quite frankly, the credit crisis that Japan is going to have is going to be far more serious than Greece. Japan makes a difference. They’re a big country. Greece is an ant hill.

Think of the problems that Greece is causing. We haven’t even gotten the problems. The US has time. We can solve our problems, but it’s not without paying. We’re going to be locking in a slow growth economy. It’s going to be very frustrating for politicians because they are going to want to come in and sprinkle pixie dust on the economy and make something happen. And, the reality is, we can’t. I mean, the Reagan solution isn’t available to us. Now, the remedies that Reagan prescribed are where we should go for, which is smaller government, lower taxes. That’s one… and we should restructure our tax code. There are certain taxes which have better multipliers or worse multipliers depending on your point of view about taxes. But, there are certain taxes that are better for economic growth than others. But, we have to just get our debt down.

In terms of GDP, there is nothing else for it. And, that’s a frustrating position. It’s five or six years of slow growth economy.

Chris Martenson:  Well, I noticed that the US, much is made that Spain is fighting to get its deficit to 6% but maybe with luck they’ll actually get it closer to 8% deficit to GDP. Portugal is wrestling its deficit down to 6% and maybe 4% by 2013 as long as recession doesn’t stalk the land. Italy, same deal, they are hoping to get its deficit down to 2%. But, the US’ fiscal deficit is higher than any of these on a percentage basis currently. On an absolute basis it’s just gargantuan compared to these countries I just mentioned.

So, what gives here? Is there a set of rules for these small European states that’s different from the US? Or, do you see this as a Wile E. Coyote moment for the market’s perceptions of the US?

John Mauldin:  Well, what gives is Europe is in far worse shape than the US. I mean, as bad as our social security and Medicare problems are, theirs are worse. Their debt to GDP when you take in private debt is 100% more than ours, and they don’t have the ability to print money. And, the Germans are saying, nein, nein. We’re not going to print money. So, unless the ECB steps in it’s going to be… it has the potential to be very chaotic.

I keep saying that, and readers keep saying you are suggesting the ECB print? I am saying, no. I am just saying that’s the only thing that’s going to keep it from being total chaos as opposed to mere chaos. I don’t know that printing money is a good answer for what Europe has. I think recognizing that the euro as a concept doesn’t work., let’s figure out how to unwind this, guys, I think that’s the smart solution.

But, from the point of view of the United States and the rest of the world, we would like the ECB to go ahead and print to try to provide some ability to offset what could be depressions in those countries and to provide less volatility for us. That doesn’t mean it’s the best thing for Europe. There are no good solutions here. I mean, there’s no… the central bank printing money doesn’t solve the problem. It just is a different way to address it than default.

Chris Martenson:  Well, just spreads it out over everybody instead of a few concentrated participants.

John Mauldin:  Well, that’s correct, and which is why the Finns and the Germans and the Dutch are saying, well you guys. We didn’t contract for the Greek and the Portuguese and the Italian. That was your problem. You are wanting us to help pay for the problem in terms of lower buying power for our currencies. So, that’s a conversation the Europeans have to have.

I mean, it’s how much do they want the Euro? How much do they want this concept of the union versus how much do they want to pay for it? Which, is the same problem the US is going to have. Our problem is how much healthcare do we want and how much do we want to pay for it? That’s what we’ve got to decide. That’s our big issue. Everything else can be solved. Everything else is fixable. I mean, the healthcare issue is coming home to me in a very, very personal, dear way.

One of my children – in her 30s – has just developed some very, very bad scans in her throat and on her thyroid. They don’t look good. She doesn’t have insurance. If it turns out to be what it’s looking like, $75,000 – $100,000 later, what do you do? I mean, that healthcare is an issue that we have to deal with in a country. There are no good solutions. You can’t deal with it without restructuring your entire tax code. And, meaning not just the rich pay, but everybody is going to pay more. That’s not what we want to do. Everybody wants somebody else to pay. If we want to have healthcare, we’re all going to have to recognize there’s a cost to that.

If the European Union wants to have their union, there’s a cost and it’s going to be loss of sovereignty to their countries, it’s going to be loss of control over their budgets, and it’s going to be loss of control over the value of their currency. And, they may decide that it’s worth it because they want the union. The United States, when we went from the Articles of Confederation to the Constitution, that was not a foregone conclusion when they called that meeting in Philadelphia, that we would walk away with a constitution. Basically, you had four or five guys hijack that convention: Adams, Hamilton, Jefferson, Washington. Men of stature. Men who could command a presence. Who got these guys in the room and said boys, we’re not walking out of here without a constitution.

We don’t see that in Europe today. I don’t see a Hamilton or a Madison or Washington with a stature or a plan to walk away with something. They’re still trying to figure it out.

Chris Martenson:  Well, perhaps history hasn’t quite delivered us to that moment yet. I see that…you know when I look at this debt super cycle and I pull out my handy chart of total credit market debt starting in the 70’s, we note that debt has been compounding faster than GDP for all of those decades since. And, that breeds a certain type of mentality – institutions, social conventions, political parties, people who are potentially not trained in the art of negotiation and compromise. We’ve been able to have one of everything. Up to this point we’ve put in on the credit card as it were.

So now, we’re at that moment I guess you are saying that super cycle has ended. Now, we’re down to the hard part, which is yes, you have to set priorities. You have to make tradeoffs. You can’t have everything. No we can’t have a tax cut, two wars, and a functioning healthcare system – pick one, or two maybe. But, is that what you’re saying? We’re down to the hard decisions?

John Mauldin:  The line from a great Italian that people do not accept change until they see the necessity and they only see the necessity in moments of crisis. We’re at the place where, and the developed world in general is at the place where we’re going to have to change. I mean, Canada and Sweden when through this in the 90’s. And, everybody else looked around and said, poor Canada, poor Sweden. It wasn’t fun for them. They had to… it was major restructuring on their parts. And, they’ve come through it now and now they don’t have the crises because they were like the cat on the hot stove. They’re not getting on any stoves that are hotter than hot.

Well, the developed world didn’t learn a lesson from watching them. And, we went on. Now, sadly, simultaneously we’re seeing much of the developed world going to have this crisis all at the same time, within three to four years of each other. That’s not good for world growth. It’s not good for globalization, all these things. We’re at a place where we have to make hard decisions. And, when you get politicians with a crisis, it’s hard to say what they’re going to do.

I mean, I can tell you what I think they should do, but they’re in a crisis. And, when you read the stories of how decisions are made by politicians in the middle of a crisis, it’s not comforting. I mean, they’re picking up the phone to each other and saying, Bill. What do you think we should do Bill? I don’t know Jim. What do you think we should do?, they are working it out as they go along. There’s no master plan here. There’s nobody with a playbook that says it’s time to call; it’s third and long. Here’s the play we got. No, you’re making it up as you go along.

Chris Martenson:  You just waltz into Congress with a three-page memo and a request for seven hundred and fifty billion. That’s what you do.

John Mauldin:  Well, let me just say this: I think the media… I’ll date this broadcast, but we just had Gingrich Saturday night win in South Carolina. And, on Sunday morning I watched the talk shows – that’s one of my vices. And, they just savaged Gingrich and they savaged the voters who voted for Gingrich. I mean, a lot of them were the conservatives doing it. Because they don’t understand. Voters are scared I think. A growing percentage of this country is scared because they look at the debt, they look at the deficit, and they say: This can’t be good.

Now, some of them understand the problems, but not many. They just instinctively know this can’t be good. And, they’re right. So, they’re looking for somebody that will tell them, I can fix it. Well, I like Newt. I’ve met him before. We text back and forth, but he can’t fix it. Boehner  can’t fix it. I’ve met all these guys. There’s no fix. There’s a hard slog.

There are things you can do that are better than others. And, I hope that as a country, we choose those. But, we have a difficult road a hoe. And, I think that’s what voters are saying. They’re saying, guys let’s just make the difficult choices. Let’s get on with it.

Chris Martenson:  I’ve been reading you for a while and you’ve seen these difficulties coming for that entire time. And, for a good portion of that time, you’ve been using the term ‘muddle through’, which you’ve used in this podcast as well. If I can paraphrase, “it’s the position that things will neither be too great nor too awful. We’ll muddle on through.” A temped bowl of porridge perhaps. Now, you’ve recently pinned a piece entitled, starring into the abyss, which captures a decidedly gloomier view I would say. And, that you now hold, and seems to articulate far more serious risks than any lukewarm bowl of porridge I’ve ever run across. Has there been a shift in your thinking here at this point in time? Are you looking for something maybe different than muddle through right now?

John Mauldin:  I certainly see the possibility. I don’t think Europe muddles through. Europe is going to have serious recessions., and some companies are going to experience depressions, as in four to five years of real turmoil. Greece has no choice. Portugal has no choice. Italy is going to be in a long-term recession. France is going to, I think, in four or five years, hit the wall. I mean, these are countries that the word muddle through doesn’t apply to.

The US has the potential to create a muddle through economy. That’s our best case. Now, if we don’t solve the problem, then we don’t muddle through. I want to be optimistic… and I hope we do. I still think people in America are slowly coming around. I am in the process of talking with some other writers. We may in fact try to do a book based around this. What we’re hoping to do is set out the issues without really describing an answer in terms of whether it’s better to have more healthcare or less healthcare. I mean, we’re going to say, here’s the costs. Here are the choices that we can make.

Now, we as a nation have to collectively come together and make some of these choices. But, we need to understand that there are no choices which don’t have costs. And, I mean we can choose that we want less healthcare. It doesn’t seem… the voters when you get all the polls, they don’t want that. They also don’t want higher taxes. You can’t have both. We’re going to have to choose. And, we have to recognize if we have higher taxes it’s going to slow growth down and it’s going to reduce potential employment. That’s just the rules. That’s how it works.

That may be a price we’re willing to pay. That’s what we’ve got to decide as a country. We’ve got to…either that or we’re going to have to spend less somewhere else. We can’t continue on in the same pattern. So, if we make the decisions, if we put ourselves on what I call a guide path to a balanced budget, we can’t do…we don’t do it all at once. We don’t wake up and say, we’re going to balance it all today. Well, that’s a depression for us. That would just be economic suicide. But, we can reduce the deficit by, the one percent GDP a year, two percent of GDP a year – which is serious when you’re deleveraging like that.

That’s a serious consequence to GDP because… I won’t go into any equations today. But, it does reduce potential GDP when you’re already at 90% of debt, which is a headway to growth. So, to me, muddle through is one to two percent growth over time and the US has the potential of having that over four or five years while we’re deleveraging. If we do it correctly. If we don’t do it, then what we’ll have is more or less of the same until the bond market starts to raise rates and then we become Italy.

Chris Martenson:  So, let me ask you very important question here, which is to step outside of the economic arena for just a second. This is a fairly germane question I hope. My view aligns with what Jeremy Grantham has now come to as well. Around the idea that high oil prices are a new, structural and permanent reality because we’ve passed geologically easy, cheap, high net, energy oil., the tar sands and the Ghawar field in Saudi Arabia have nothing in common with each other from an energy return, from a capital return standpoint.

So, does peak oil at all influence your outlook at this stage? Or is this something you think is not a concern right now?

John Mauldin:  Well, I’m not really a believer in peak oil. I’m a believer in peak, cheap oil, which is more to what you were saying. I mean, there’s plenty of energy out there, it’s just not cheap anymore. So, we’re going to end up having to become more efficient and we’re going to end up spending more of our resources on having that energy because we’re an energy dependent culture and civilization. So, it means that we’re going to be buying less of something else. That’s the hard fact of nature.

I mean, until somebody can get cold fusion to work or whatever. But, it does play into our situation. I mean, one of the things that we in the US have to do is we have to figure out how to be energy independent because we can’t deleverage our country and reduce our deficits until we become energy independent because you have to get your trade balance together in order to be able to get your fiscal balance together.

That’s another economic equation. Till you sit down with people, you understand, it’s arithmetic. It’s balance. It’s 400 years of accounting. But, we in fact have to get our trade deficit down in order to be able to deal with the Federal deficit. All of those things have to equal zero at some point. And, energy is a big part of our trade deficit. If we want to balance the budget, we’re going to have to become energy independent. And, we can become energy independent within four to five years if we basically look around to each other and say, we’re going to punch a lot of holes in the ground.

We’re going to do what it takes to get that energy out and we’re also going to make ourselves more efficient. We can get there. But, it will create a lot of jobs by the way. But, you’ve got to have the willingness to do that. You have to decide… a majority of the people have to override the lurch to the left and saying anything that has to do with carbon fuel is bad and we should let the civilization rot rather than use carbon based energy.

That’s another cultural decision we have to make. If we want to be able to have any form of economy, we’re going to have to make some very, very hard decisions there.

Chris Martenson:  So, I hear you saying the end game has arrived. In the end game we really only have a few choices here. There’s too much debt. So you’re either going to pay it off, you’re going to default on it, you’re going to print it away, some combination of all three. And, so the constructive steps that we need to take first is to understand the nature of the predicament. We have to just look at it and say look, we’re not going back to how things used to be through any combination of magic policies. We’re in a period of deleveraging. So, we can either do it responsibly or we can do it chaotically. Those seem to be our choices here.

And, that there’s a series of priorities that are going to have to be established. Which means, we have to get the dialogue open so we’re having the right conversations. Difficult in this country in an election year because we seem to default to – in my judgment – non-priority discussions. But, at any rate, I feel that around the constructive steps that maybe our society in the US could take is an individual though. If you… I know a lot of concerned individuals. Some of them are very wealthy people, some of them have no money. They’re concerned for the same sets of reasons you articulated around the voters.

Something’s wrong. What do we do here? What is the concerned individual sitting here at this moment in the timeline, what do they do that helps them best protect their quality of life at this point?

John Mauldin:  The first thing you’ve got to do is recognize that this is not business as usual. You don’t stick your money in an index and hope it’s going to grow. It’s going to be volatile. Your measure for investing should be zero rather than how did you do relative to the market. It should be an absolute return type world. You’re not going to get the compound growth and returns that you’ve had in the past that you wanted to have. But, that’s not what you’re trying to do. You’re trying to get to the other side of this crisis. And, you’re trying to get to the other side of the crisis with as much as your wealth as you can have today and as you can save so that when opportunities do come, when we do get to the other side of the crisis – and we will – that you have the ability to take advantage of the opportunities that are going to come.

I mean, that’s… alternative investments… I think there should be some goal there. You are going to have to look at a more strategic investment. What’s going to do well in this type of environment? A lot more income oriented. A lot more absolute return oriented. There are hedge funds, commodity trading funds, that are starting to become available to the average person in 40ec mutual funds. For higher net worth investors, they have different opportunities, which they have a little bit bigger menu.

I sat down with one very, very, very large fund in Asia when I was there last week. They said, given everything you’re talking about John, what should we do? I said, well you’ve got X billions now. You’re goal for the year should be to have the same number of X billions at the end of the year. You should manage this portfolio for zero percent return. And, if you get anything extra, that’s fine. If you are going to have equities you need to hedge it. Everything needs to be hedged because we don’t know what Europe is going to do.

You are putting your entire portfolio at risk to some political decisions that nobody around this table knows what those decisions are going to be. So, you don’t know how to position. And, those decisions could be good ones for the market, or they could be bad ones. And, today I think that’s a risk investors should be very, very careful of. We should just recognize that’s the time period we’re in. It’s not the 80s and 90s anymore.

I mean, when I was writing in the very, very late 90s and early 2000… I came out with Bull’s-eye Investing in 2003. I said, guys we’re in a circular bear market. The market is going to go sideways for a very long period of time – average of 17 years. People were telling me, John you’re such a pessimist. You’re a bear. I’m going, I’m just telling you here’s what the cycles look like. Here’s what the data looks like. And, here’s what the research gives us about human psychology.

Sure enough, I mean, what I was saying was going to happen is pretty much coming out. In four or five years I will probably turn bullish again on the markets at some point because we hit the bottom of that cycle. People will say, John what are you looking at? You smoking some funny data? How could you be bullish? I would say the data is telling us it’s time to start thinking about taking some more risk and putting the risk back on the table. These things move in cycles and investors need to recognize that as these cycles…I mean, between the secular bulls and bears as they change. The style of investing that works in one is the opposite of what works in the other.

Chris Martenson:  A period of maximum safety. Return of principle, not a return on. He who loses least, wins most. All of those bear market aphorisms.

John Mauldin:  All of